Banking group Lloyds (LSE: LLOY) is a familiar name across the country. As well as Lloyds bank itself, the financial services powerhouse operates businesses including Bank of Scotland, Halifax and Scottish Widows. The company is the country’s leading mortgage provider. On top of that, it currently has a well-covered dividend yield of 4.7%. So, would it be a good move for me to invest £1,000 in buying Lloyds shares for my portfolio today?
Strong business in a weakening economy
The business model at Lloyds is less complex than at some UK banks with large international operations, like Barclays and Standard Chartered. By focusing on the UK, the company has tied its fortunes more closely to those of one market. That can help make it more streamlined and easier to run. On the downside, the lack of geographic diversification means that if the UK economy does badly, Lloyds could well be affected negatively.
I also like its emphasis on retail and commercial banking. It avoids some historically risky but lucrative areas such as investment banking. That can help reduce the scope for dramatic swings in profits from one year to the next arising from getting involved in exotic transactions.
But the streamlined business model can only do so much for Lloyds, in my opinion. It is still a bank and the fortune of banks is always tied at some level to overall economic performance. If the economy enters a prolonged period of weak performance, that is likely to drive up customer defaults. Such bad debts can eat deeply into profits. Indeed, we saw that at Lloyds during the last financial crisis. The business has changed since then – but I do not think the overall drivers of the banking industry have. It remains difficult for a bank to do well in a very weak economy.
A bull case for buying Lloyds shares
Arguably, though, all of those risk factors are already priced into Lloyds shares.
The price has fallen 30% over the past five years, for example. The stock now trades on a price-to-earnings (P/E) ratio of only 8. That looks cheap to me, although the P/E ratio is not the only way to value bank shares.
The strengths of the group help give it a long-term competitive advantage. If I spent £1,000 on Lloyds shares today, I would hopefully earn almost £50 a year in dividends and may have the potential for long-term price growth once the economy enters its next growth cycle in future.
My next move
However, I do not plan to add Lloyds shares back into my portfolio. The next few years look bleak for the economy. If loan defaults increase enough, I expect banking shares to be hit – including Lloyds.
The dividend is attractive, but there are a number of financial services firms currently offering even bigger dividends that I think have a broadly similar risk profile to Lloyds. I do not think the risk-to-reward equation at Lloyds makes the shares at their current price a compelling buy for my portfolio.